The Risks of Chargebacks & How to Handle Them

The Risks of Chargebacks & How to Handle Them

The Risks of Chargebacks & How to Handle Them

Accepting all forms of credit cards allows your business to remain competitive by offering customers the convenience of using their favorite payment option during checkout. However, depending upon how your business is structured, you might stand at risk of receiving a higher-than-normal level of chargebacks, which can cause not only your business to be shut off from processing credit cards, but can lead to lost revenues and lost inventory.

For this article, I will discuss the structural foundation of credit card chargebacks, how they occur, how to avoid them and how to win a chargeback case if you find your business involved in one.

How the Credit Card Processing Cycle Works

To better understand a credit card chargeback, we should first understand the processing “cycle.”

1. The Major Players

The card brands: These include brands such as Visa and Mastercard (V/MC) and they regulate a group of member banks who use their trademarks in the market.

Member banks: These include both card-issuing banks who are responsible for distributing individual bankcards to consumers, along with sponsoring banks who partner with merchant service providers (MSPs) to approve merchant accounts.

2. The Process

So if Sarah is approved by an issuing bank for a credit card with a $1,000 limit, she may decide to buy $200 worth of products at Mike’s Clothing Shop, which was approved for a merchant account by a sponsoring bank/MSP.

Mike would swipe Sarah’s credit card, the MSP would send the data to the sponsoring bank, who then sends it to the card brand (V or MC), who then sends it to the issuing bank to verify Sarah has sufficient credit remaining to satisfy the purchase. If she does, an authorization code is provided with an approval notification to Mike, who then hands the products over to Sarah at checkout.

Once Mike batches out his credit card terminal at night, within 24-48 hours the MSP will deposit the sales amounts to his bank account and bill him at the end of the month for interchange (baseline rates for every card type ran), the mark-up of interchange (how the MSP makes money), along with other fees such as batch fees, statement fees, paper fees, etc. Meanwhile, Sarah would be billed about 23-30 days later via her issuing card bank to pay for the $200 purchase.

Chargeback Disruptions

In the example provided above, let’s say Sarah wanted to dispute the $200 transaction at Mike’s Clothing Shop. This dispute would be known as a “chargeback” in which Sarah’s issuing bank would open a dispute case to investigate the situation. Sarah would have a couple of options provided in terms of the basis of her dispute.

Fraud Claim: This is where Sarah would state that she never authorized the $200 transaction and states her card was either stolen or used in another unscrupulous manner.

Quality Claim: This is where Sarah would state that she never received the items from the $200 transaction for, or if the items were received, they were not received as Sarah was promised by Mike’s Clothing Shop.

Clerical Claim: This is where Sarah would state that she actually returned the items represented by the $200 transaction to Mike’s Clothing Shop, but Mike has yet to issue Sarah a refund to her credit card for the items returned. This could also be where Sarah states that she only purchased $175 worth of items, but was billed $200 for it. Or this could be where Sarah states that she was billed $200 twice in a duplicate billing error.

Technical Claim: This is usually an error within the communication ecosystem of the card brands, the issuing bank and the sponsoring bank/MSP. Sarah would not usually submit a chargeback/dispute case in relation to a technical claim.

Chargeback Dispute Process

When a consumer initiates a chargeback dispute, the following is usually the process that results:

  • Consumer begins the dispute either online through their issuing bank’s credit card portal, via telephone, or via mail.
  • The issuing bank would freeze the transaction in the consumer’s account so the consumer isn’t being billed for said transaction until the dispute process ends.
  • The issuing bank would then send the information to the MSP/sponsoring bank of the merchant account in particular and the MSP would open the chargeback case. The opening of the chargeback case usually creates a $15-$50 fee along with a retrieval fee of another $15-$50 that the merchant must pay.
  • The MSP will ask for receipts and other information from the merchant in relation to the transaction to begin the process of investigation and fighting the chargeback claim. After some time, if the merchant isn’t able to provide said paperwork to fight the claim and/or if other details are revealed that show validity to the chargeback claim, the consumer ends up winning the claim with the transaction being removed from their credit card account activity.
  • This is when the MSP would go to deduct the cost of the transaction back from the merchant in particular, however, if the merchant doesn’t have the sufficient amount of funds to cover it, the MSP might be on the hook to cover the cost. This is why “card-not-present” merchant accounts are tougher to approve for a merchant account, due to the higher risk of chargeback claims (along with the loss of said disputes by the merchant).

Friendly Fraud Is a Common Issue

Friendly fraud dispute cases are a major issue for merchants today, as many unscrupulous consumers will state that they never received items from a merchant that were actually received, or that they never authorized the purchase of items that they actually did authorize.

Friendly fraud is usually of a higher quantity in card-not-present merchant account environments, versus that of card-present merchant account environments. Card-present environments are simply where the merchant would see the customer face-to-face, which would usually include having the customer sign a receipt at the end of the sales cycle. These environments make it difficult for unscrupulous consumers to make such frivolous claims. However, in card-not-present environments, where the transaction takes place over the telephone, through the mail, or through the Internet and the merchant never seen the customer, it makes it easier for friendly fraud cases to be generated.

Tips to Avoid Chargebacks & How to Deal With Them

If you are a card-not-present merchant, it might be difficult to completely avoid chargebacks due to the unscrupulous nature of some consumers today. However, here are some best practices you can employ:

  • Have a clearly defined return policy.
  • Have clearly defined product descriptions/product expectations.
  • Have posted information where customers can call for customer service, billing questions and other related support issues.
  • Do not employ any bait & switch tactics, unethical employees or any other unethical operational aspects which could lead to bad customer service experiences.
  • Send order confirmation emails and include shipping tracking information.
  • Implement fraud management systems to verify addresses, card security codes, etc.
  • Conduct additional verification on bulk orders, orders coming from international areas, and any other order that might seem out of the ordinary, such as multiple orders being made over a short time period, or where you have different billing and delivery addresses, or orders with a lot of attempts on the card number/expiration date/security code.
  • Finally, chose to work with certain chargeback management firms that can help you fight/win cases where chargebacks are already filed, along with, providing various alert procedures upfront to avoid chargebacks from being reported.

This article was originally written on August 31, 2017 and updated on September 2, 2017.

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